Thursday, March 11, 2010

An Investment in Investing

The goal of this Global Midwest site is to help Midwesterners think like Midwesterners -- that is, as inhabitants of a big and important heartland region, not as the isolated denizens of a bunch of states. For this reason, I'm thrilled by the publication this week of our latest Global Midwest Policy Brief, on the need to generate a regional venture capital fund, to re-energize the regional economy.

It takes a lot to kick-start innovation and promote new ideas -- smart people, good ideas, stimulating education, helpful business services. But what it really needs is money -- especially adventurous money, put up by investors who are willing to take a risk on a new and unproven idea. This money is called venture capital and, to a startling degree, it's what the Midwest doesn't have.

Samuel's proposal is to help existing venture capital funds in the Midwest by (1) setting up a regional fund of funds that would invest in these existing funds, enabling them to expand their lending, and (2) encouraging Midwestern governments, universities, foundations and other entities to focus on venture capital investing.

His overall point is that, while the Midwest has some venture capital available, there's not enough of it, and it isn't enabling the region to compete with capital-rich regions on the two coasts.

Right now, the Midwest has a handful of private venture capital funds, useful in themselves but pretty small by national standards. The biggest is Venture Investors, headquartered in Madison, Wisconsin, with some $200 million under management. Not bad -- until you consider that the average American venture capital fund has more than $250 million under management. In other words, our biggest is smaller than the nation's average.

In addition, most Midwestern states have their own venture capital funds, many of them funded by money from the tobacco company settlements. Samuel's Third Frontier Project was one of these funds, and probably the most successful.

But these funds, by their nature, are inadequate. First, they're too small: in a globalizing world dominated by huge national economies and vast pools of venture capital, no Midwestern state can compete all by itself. Second, they're too political: in most states (Ohio is an exception), this funding has been spread thinly across the landscape, funding lots of projects to please lots of politicians, rather than focusing on a few really promising projects. Also, much of this funding was aimed at immediate job creation, to give governors something to brag about before the next election, rather than at long-term economic development.

The result was about what you'd expect -- a lot of fairly small and non-transformative projects that never amounted to much, while the really big prospects went to California in search of really big money.

Samuel notes that the Great Lakes region accounts for about one-third of all NIH grants and American R&D but controls only 14 percent of the nation's venture capital pool. Actually, it's worse than that. As he points out, the Great Lakes statistical region includes places like New York City and Philadelphia, both of which house venture capitalists. When you eliminate these honeypots, the Midwest proper probably commands only 4 percent of the nation's venture capitalists.

This means that all the good ideas that spin off those NIH grants and R&D have to go east or west to be turned into companies and jobs. If money makes the world go around, we're out of the orbit.

We've got another built-in problem here. As the saying goes, venture capitalists like to be close to their money. That is, they like to keep an eye on their investments and don't want to travel far to do so. This makes life easy for investors in Silicon Valley or the Boston region, where most companies are within a few miles' drive. But it's harder in a region like the Midwest, where major cities and, especially, universities are just far enough apart to be an unhandy commute.

There's no solution to this problem short of a true high-speed rail network that would brings these cities and universities within an hour of each other. Until this net is built, Midwestern distances will continue to be a problem.

But Samuel's ideas can be a big help.

He notes that venture capital investing is hard work. Most prospective borrowers have no track record, so investing in them involves time- and labor-consuming study and research. This is a lot of work and severely limits what a single investor can do.

But a fund of funds, using its money wisely, could finance more of this work. This, in turn, would expand the possibilities for investing.

In addition, the fund, being regional, could sail above the political push-and-pull that hampers so many state-based funds and enable financing of ventures that would lead to long-term economic growth. As Samuel points out, venture capitalists want to make money while politicians want to create jobs. One promotes the economy, while the other gains votes.

In a region that has to reinvent its economy, long-term gains are the way to go.

Frank Samuel has done our region a service, and I urge you to read both his report and his Policy Brief.